Cheaper lumber is good for inflation but bad for Lowe’s and Home Depot

Stocks gained yesterday as some guarded optimism helped to prop shares. Bond yields continue to push higher as investors try to figure out what the Fed’s next move might be.

Paying the price. Good news! Congressional leaders did not walk out of debt ceiling discussions yesterday. In fact, House Speaker McCarthy sat next to the President in the White House for a photo session. They were… optimistic that a deal could be reached. On the importance of that deal, Treasury Secretary Janet Yellen sent a letter to House Republican leadership stating something to the effect that June 1^st is a real thing, perhaps more real than her team thought when they initially proposed it as the drop-dead date. Further, she stated, that a failure to raise the debt ceiling would cause harm to American families. Now, I know that this is all part of that well-oiled political mechanism that happens day to day in DC. For the most part, unless there are actually policy changes, we are best off filtering out that noise. That is why my regular readers oft hear me say “focus on policy, not politics.” However, and quite unfortunately, sometimes, there is a cost to politics.

Now, I am not going to focus on whether a significant reduction in spending while the economy is teetering on a recession is likely to cause significant job losses in 2024. I am also not going to focus on how lawmakers are likely going to have to change whatever they agree on if we end up in a recession. Those analyses are for another morning note… once we know what the cuts are going to be. This morning I want to start with a chart of the historic yield of the June 6, 2023 Treasury Bills. Take a look at it and keep reading.

On this yield chart, you can see that yield came down earlier in the year as investors began to believe that the Fed would lighten up on its rate hiking. For folks holding those bills it meant that the value of their securities went up, which is good if they were planning to sell the bills. Most people hold them to maturity, but it sure feels good to have the value of your securities go up… for a change. The bigger picture for stocks was positive as well. Lower yields clear the way for gains in classic interest rate sensitive sectors like utilities and real estate, in addition to newly interest rate sensitive growth stocks (that was partially tongue-in-cheek, because growth stock investors classically did not focus much on yields). The story, as told by the chart, is that nothing lasts forever, as you can see the exact point at which nerves on the debt ceiling discussion were struck. It’s not like we didn’t know it was coming FOR THE PAST 6 MONTHS, but the market was focused on other things like rate hikes, recession, and inflation. Surely, there would be the traditional saber rattling which would lead to an agreement, followed by both sides claiming victory, one in the White House Rose Garden, and one on the steps of Capitol Hill. That is how it always happens, give or take. BUT NOT THIS TIME.

This time, lawmakers on both sides decided to dig their feet in and bring the US dangerously close to a default. If you ask most people in the beltway, they will whisper to you “it’s just politics, man, they will wrap it up and fix it by 11:45 PM on May 31^st!” Maybe so, but, unfortunately, the world outside the beltway is going to pay the price, in fact it already has. You see on my chart above how yields rose almost an entire percentage point since late April? Those yields rose because investors needed to be paid more to take a risk that the Treasury would be late on its payments. You may not know it, but the Treasury is constantly selling short-term notes, referred to as Bills for its liquidity requirements. That is normal. The cost of all that short-term borrowing is dictated by the yield it must pay investors. So when yields rise by +25%, as they have, the Treasury’s… OUR Treasury’s short-term borrowing costs go up by +25%. You don’t believe me? On April 12^th, the Treasury auctioned 4-week Bills at 4.03%. Just last week, the Treasury auctioned 4-week Bills at 5.37%! Now, there are a few factors in that rise. Yes, indeed investors are a bit more concerned this month than last that the Fed will hike again next month. But all the gesticulating in Washington has caused front-end yields to bubble up as we saw above.

In their quest to cut spending as the US is speeding toward a potential default, lawmakers are actually… increasing our spending. The fact that politicians are willing to risk the US’s good credit for this very public political discourse will have longer-term credit consequences… as it has in the past. They say on Wall Street that memories of gains are stored in our short-term memory, but losses are never forgotten. For now, we can only hope that the negotiations are ultimately successful, and that the losses will be minimal… but they won’t be forgotten.

WHAT’S SHAKIN’ THIS MORNIN’ ☀⛅

AutoZone Inc (AZO) shares are lower by -2.28 in the premarket after the company announced that while it beat on EPS, it missed on Revenue targets as a result of weaker-than-expected sales in March. In the past 30 days 26% of analysts have adjusted their targets, 6 up, 0 down, and 17 unchanged. Potential average analyst target upside: +4.6%.

Lowe’s Cos Inc (LOW) shares are lower by -1.30% in the premarket after it announced that it beat on EPS and Sales estimates but lowered its full-year guidance. The company cited that decreases in lumber prices, softer consumer demand, and bad weather were the cause for the weaker guidance. Rival Home Depot made similar cuts last week, citing the same drivers. Dividend yield: 2.06%. Potential average analyst target upside: +13.0%.

YESTERDAY’S MARKETS

Stocks closed higher yesterday as hopes for a debt ceiling deal improved. The S&P500 gained +0.02%, the Dow Jones Industrial Average fell by -0.42%, the Nasdaq Composite Index climbed by +0.50%, and the Russell 2000 Index jumped by +1.22%. Bonds gained and 10-year Treasury Note yields climbed by +4 basis points to 3.71%. Cryptos slipped by -0.17% and Bitcoin gained +0.18%.

NEXT UP

• S&P Global Manufacturing Flash PMI (May) is expected to have slipped to 50.0 from 50.2.
• S&P Global Services Flash PMU (May) may have slipped to 52.5 from 53.6.
• New Home Sales (April) is expected to have fallen by -2.6% after jumping by +9.6% in March.
• Dallas Fed President Lorie Logan will speak this morning.
• After the closing bell earnings: VF Corp, Palo Alto Networks, Agilent Technologies, and Intuit.